Author Topic: READER CASE STUDY: Smashed Debt! Now What??  (Read 5596 times)

gwdavep

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READER CASE STUDY: Smashed Debt! Now What??
« on: June 12, 2015, 11:50:02 AM »
Hi Everyone. Below is my case study outline. I am hoping to get some guidance on what our best next step should be toward Early Retirement. Thanks!

Life Situation:
Married filing jointly,
No children or dependents,
Living in Southern California,
Ages 32 and 29 (wife),
I work on a commission basis as an independent contractor for a small business,
Wife is a teacher

Gross Salary/Wages:
Me: fluctuates, but about $36,000 per year so far in this new position, I expect this to grow
Wife: $50,000 per year

Pre-tax deductions:
Wife Retirement: $4,500 per year

Other Ordinary Income:
Interest from Real Estate Loans: $9,540 per year ($4,770 in 3 years, $0 in 7 years as notes get paid off)

Qualified Dividends & Long Term Capital Gains: n/a

Rental Income, Actual Expenses, and Depreciation:
8 Income Properties
Rent ranges from $600 to $800 per month
Net income: ~$4800/mo.
Expenses: ~50% of gross income
Split w/ partner: 50% of net income
My net Income: ~$1,200/mo. ($14,400/yr.)
*Owned free and clear between me and a partner. We split profits 50/50.
*Plan to use this income to cover part of our spending in ER.
*All rentals are outside CA. I guess I could go live in one if we were desperate.
(Note: much of this income just started this year)

Adjusted Gross Income: $105,440

Taxes: We got a refund for 2014. I believe based on losses on our income property and the fact that I was unemployed for most of the year. Iím not sure how to calculate this exactly so Iíll estimate a 20% effective tax rate.
Taxes: ~$19,180 (I would love some help with this part if anyone is up for it)

Current expenses:
Average spending is $3,600 per month.
May 2015 broke down as follows (via Mint):
Rent: $1,695
Gas: $295 (2 cars driven in opposite directions for work)
Groceries: $737 (out of control! Grass fed beef, organic everything, farmerís market, etc)
Other Food: $306 (also out of control. Eating out, coffee shops, Motherís Day dinner)
Utilities: $60 (gas, electric, water)
Wife Fun Money: $100
My Fun Money: $50
Misc: $301 (trips to Target, household goods, etc)
Gifts: $76 (baby shower)
Entertainment: $7.99 (Hulu subscription)
Internet: $40
Pet Food/Supps: $25
Cell Phones: $0

Expected ER expenses:
I want to say our ER expenses will be less than they are currently. I think it will greatly depend on what we do about our housing cost.
I estimate ER expenses to be about $3,000 per month.

Assets:
$11k in cash
8 Rental Properties valued at about $350k
4 Seller Financed Properties (I am the lender)
$2,500 at Lending Club spread across 100 notes
 
Liabilities: Recently paid off student loan. No other debt.

Specific Question(s):
Iím clear that we have some work to do on our expenses if ER is the goal, especially in the food and housing department. My main question is about housing. The rent vs. own battle continues to rage on the Internet. Everyone seems to have a break down of why one is better than the other. If the goal is ER should we save for a down payment, buy a house, and pay off the mortgage rapidly to decrease our living expenses? After a mortgage is paid off the cost of owning will be much less than renting a similar home, right? Or should we continue renting and invest the down payment money? We might have to move out of Southern California to even think about buying as this area seems to be well out of our price range. Thank you for any guidance, advice, and questions.

- David
« Last Edit: June 12, 2015, 02:32:58 PM by gwdavep »

KCM5

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #1 on: June 12, 2015, 12:04:24 PM »
Explain your income properties - it looks like each property (8) rents for $600/month?  I take it these are not residences and you couldn't live in one of them, correct?

It looks like you have quite a bit of room between your expenses and your income. I'd throw the money into a tax deferred account personally (shelter it from that high CA income tax), but if you want to buy a house that would be better off being saved for a down payment.

nereo

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #2 on: June 12, 2015, 12:07:42 PM »
Quote
Specific Question(s):
Iím clear that we have some work to do on our expenses if ER is the goal, especially in the food and housing department. My main question is about housing. The rent vs. own battle continues to rage on the Internet. Everyone seems to have a break down of why one is better than the other. If the goal is ER should we save for a down payment, buy a house, and pay off the mortgage rapidly to decrease our living expenses? After a mortgage is paid off the cost of owning will be much less than renting a similar home, right? Or should we continue renting and invest the down payment money?

I'm a home owner with a mortgage, but I will say that it's not for everyone, or for every market.  Heck, I'd say that in many cases you will be better off renting - strictly from an economical point of view.
If your goal is to FI, then what you need are assets that generate enough income to cover your expenses.  Yes, owning your own home means your expenses will drastically be lowered, and today's super-low interest rates makes it less expensive to own a home, but you will give up a decade or more of investment contributions - that's your opportunity cost.

To determine whether it makes sense for you to buy a house in your area, I'd start with this calculator:
Quote
http://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html?_r=2&abt=0002&abg=0
Then ask yourself questions like "do I like doing my own repairs?  Do I want to be tied to this one particular area?"

Finally, regarding your taxes, I'd strongly advise that you take better advantage of tax-advantaged accounts.  You and your wife are elegable for $11k (total) in IRAs, plus you mentioned she ahs a retirement account (a 401(k)?).  What options do you have at your workplace?  Given that your marginal tax rate is in the 25% bracket, you could reduce your tax burden by thousands of dollars while going towards FI.
Besides that, food ($1,000+), Misc. ($300+) and transportation (~$300 for fuel alone, plus wear-and-tear which is probably about as much) are your biggest targets for optimization.

Your 8 (eight!) income properties sound very interesting - what do you owe on them, what is your interest rate, and how do they fit into your FI/RE plan?

expectopatronum

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #3 on: June 12, 2015, 12:08:43 PM »
You already nailed down that crazy category of food - $1043/mo to feed 2 people is insane. Check your statement from last month. How often did you go out? It might be helpful to put things in terms of frequency rather than absolute value. As in, did you go out 2x/week? More? Can you cut back to once every other week? Once a month?

For groceries, where are you shopping? Are you buying on sale? Can you get creative and buy some of your items frozen or canned? (I prefer fresh, but in some types of recipes, it just won't matter.) If you don't budge on the type of food, then you'll either need to 1) reduce your intake of it (e.g. meat only every other day), 2) waste less, or 3) buy on sale. We are on track for $200/mo this month for 2 people on pretty good (but not organic) food, lots of meats & veggies, but also live in a pretty LCOL area. You could assume a comfy $300 for groceries, I think.

I honestly think you could be easily cutting back to $500/mo food total. Savings: $500

I know everyone's going to chime in on this too, but the gifts/misc/allowance category is killing you at >$500/mo. If you're spending $76 on a baby shower gift, I'm kind of imagining your Christmas costs are probably nuts, too? Track down what the misc is going to. It's my firm opinion that every trip to Target for a $3 gallon of milk makes you $100 poorer, haha. Consolidate your trips/random errands, and you're likely to see lower spending, less impulse buying, less gas costs. You should try to meet closer to $200/mo for clothes/gifts/stuff. The misc category killed us because I spent like an idiot on clothes and housewares, both endless pits of never-enough.

For mortgages, I'm no expert, but in California I'd be very wary of buying...and someone here once talked about the beauty of a mortgage at a low % vs investing it over time (and also being able to deduct the interest on the mortgage from taxes every year) + benefit of inflation means the loan value essentially decreases over time...but as you are aware, you have to be choosing between investing and paying down the house. I often see people who say it's not beneficial to pay off the house early because of the math...and then they spend the money on toys/other wasteful things.

Final thought - can your wife get a job nearer town? What can you do to cut gas costs? How far are you driving? Did you include insurance, maintenance, and registration fees in your monthly car calculation?

Good start though!!

ShoulderThingThatGoesUp

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #4 on: June 12, 2015, 01:00:23 PM »
You've got a serious pay/COL issue here. Entry-level teachers make $47,000/year in Dallas: Dallas Independent School District Salary Handbook.

gwdavep

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #5 on: June 12, 2015, 01:12:33 PM »
Explain your income properties - it looks like each property (8) rents for $600/month?  I take it these are not residences and you couldn't live in one of them, correct?

It looks like you have quite a bit of room between your expenses and your income. I'd throw the money into a tax deferred account personally (shelter it from that high CA income tax), but if you want to buy a house that would be better off being saved for a down payment.

I updated my case study with the answers to your questions about my income properties.

I think I've seen this answered, but how do tax deferred accounts work in Early Retirement with all the penalties and such?

MDM

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #6 on: June 12, 2015, 01:23:26 PM »
Taxes: ~$19,180 (I would love some help with this part if anyone is up for it)
Did you try the spreadsheet in the case study sticky post?  Or https://turbotax.intuit.com/tax-tools/calculators/taxcaster/, etc.?

gwdavep

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #7 on: June 12, 2015, 01:26:53 PM »
You already nailed down that crazy category of food - $1043/mo to feed 2 people is insane. Check your statement from last month. How often did you go out? It might be helpful to put things in terms of frequency rather than absolute value. As in, did you go out 2x/week? More? Can you cut back to once every other week? Once a month?

For groceries, where are you shopping? Are you buying on sale? Can you get creative and buy some of your items frozen or canned? (I prefer fresh, but in some types of recipes, it just won't matter.) If you don't budge on the type of food, then you'll either need to 1) reduce your intake of it (e.g. meat only every other day), 2) waste less, or 3) buy on sale. We are on track for $200/mo this month for 2 people on pretty good (but not organic) food, lots of meats & veggies, but also live in a pretty LCOL area. You could assume a comfy $300 for groceries, I think.

I honestly think you could be easily cutting back to $500/mo food total. Savings: $500

I completely agree. The wife is VERY into fresh, grass fed, organic, top quality food and has turned the corner to putting these qualities way above saving money. I am going to think about strategies to get the same quality for less. I think reducing intake will be the most effective. My new goal is $300 per month without sacrificing too much quality. Thanks for the advice.

nereo

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #8 on: June 12, 2015, 01:49:32 PM »

I completely agree. The wife is VERY into fresh, grass fed, organic, top quality food and has turned the corner to putting these qualities way above saving money. I am going to think about strategies to get the same quality for less. I think reducing intake will be the most effective. My new goal is $300 per month without sacrificing too much quality. Thanks for the advice.
You don't have to sacrifice quality in order to get a major reduction in your food expenses.  The trick is to just find meals that use HQ, in season ingredients and stop paying mega-bucks for the items that are out of season, flown-in, or just plain high cost.  Batch cooking really helps, as does finding a CSA where you can get loads of organic produce for pennies - you are in SoCal, which is ground-zero for good, cheap food.  Hispanic and Asian markets are another great source of cheap ingredients.  CostCo can be a real money saver *if* you buy sensibly.

There are tons of recipes out there that will make 4 servings for under $10 (giving you two dinners and two lunches).

gwdavep

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #9 on: June 12, 2015, 01:51:49 PM »
Taxes: ~$19,180 (I would love some help with this part if anyone is up for it)
Did you try the spreadsheet in the case study sticky post?  Or https://turbotax.intuit.com/tax-tools/calculators/taxcaster/, etc.?

That turbotax calculator is helpful. Thanks for sharing that. It really showed me that using tax deferred accounts drops our tax rate from 25% to 15%. That's pretty huge!

gwdavep

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #10 on: June 12, 2015, 01:54:21 PM »
You've got a serious pay/COL issue here. Entry-level teachers make $47,000/year in Dallas: Dallas Independent School District Salary Handbook.

I agree. We are seriously considering moving to a more cost effective state. Trying to weigh the pros and cons as both of our families live within 45 minutes of us now. Tough choice. The weather is also a factor.

gwdavep

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #11 on: June 12, 2015, 01:59:01 PM »

I completely agree. The wife is VERY into fresh, grass fed, organic, top quality food and has turned the corner to putting these qualities way above saving money. I am going to think about strategies to get the same quality for less. I think reducing intake will be the most effective. My new goal is $300 per month without sacrificing too much quality. Thanks for the advice.
You don't have to sacrifice quality in order to get a major reduction in your food expenses.  The trick is to just find meals that use HQ, in season ingredients and stop paying mega-bucks for the items that are out of season, flown-in, or just plain high cost.  Batch cooking really helps, as does finding a CSA where you can get loads of organic produce for pennies - you are in SoCal, which is ground-zero for good, cheap food.  Hispanic and Asian markets are another great source of cheap ingredients.  CostCo can be a real money saver *if* you buy sensibly.
There are tons of recipes out there that will make 4 servings for under $10 (giving you two dinners and two lunches).

You are so right. I need to be more diligent on our food costs. I think planning ahead is the key. This one thing could mean sever hundred dollars a month for us so definitely worth the effort.

MDM

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #12 on: June 12, 2015, 01:59:41 PM »
It really showed me that using tax deferred accounts drops our tax rate from 25% to 15%. That's pretty huge!
That is your marginal, not overall, tax rate - just checking to ensure you know the difference.

You pay 15% on taxable (i.e., after deductions, exemptions, etc.) income between $18,450 and $74,900, no matter how much you make above that.

You pay 25% on taxable income above $74,900 (ok, there are other brackets but to keep things simple...).  If deferring taxes takes your taxable income below $74,900 you might consider using traditional accounts only until you get to that number, then use Roth for the rest.

Ricky

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #13 on: June 12, 2015, 02:07:05 PM »
You're already at MMM levels of income (you just need a paid off house house or $1695 in additional income) based on his spending, so just work on getting your spending down. It's hard for an investor to get returns right now. Both real estate and stocks are expensive. I still like real estate better though since deals are always out there. I'd add to my portfolio if I were you since you're not currently leveraged. Double your rental income and buy a house and I think you'll be pretty much set.

Also, anyone could fairly balk all they want at your expenses, but you're still at a >50% savings rate. Not sure where you live in SoCal, but $1695 still sounds fairly cheap for rent. I mean, besides the food, what other area could anyone call you out for? Doesn't look like anything to me. I have no idea how your electric + gas is $35/mo. That's mind blowing for me.
« Last Edit: June 12, 2015, 02:17:19 PM by Ricky »

ShoulderThingThatGoesUp

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #14 on: June 12, 2015, 02:07:32 PM »
You've got a serious pay/COL issue here. Entry-level teachers make $47,000/year in Dallas: Dallas Independent School District Salary Handbook.

I agree. We are seriously considering moving to a more cost effective state. Trying to weigh the pros and cons as both of our families live within 45 minutes of us now. Tough choice. The weather is also a factor.

Totally get it. There's a basic, reasonable assumption that you'll make more for most things in a HCOL area, and I just thought the information that it doesn't apply to your wife might be worthwhile.

gwdavep

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Re: READER CASE STUDY: Smashed Debt! Now What??
« Reply #15 on: June 12, 2015, 02:39:14 PM »
You're already at MMM levels of income (you just need a paid off house house or $1695 in additional income) based on his spending, so just work on getting your spending down. It's hard for an investor to get returns right now. Both real estate and stocks are expensive. I still like real estate better though since deals are always out there. I'd add to my portfolio if I were you since you're not currently leveraged. Double your rental income and buy a house and I think you'll be pretty much set.

Also, anyone could fairly balk all they want at your expenses, but you're still at a >50% savings rate. Not sure where you live in SoCal, but $1695 still sounds fairly cheap for rent. I mean, besides the food, what other area could anyone call you out for? Doesn't look like anything to me. I have no idea how your electric + gas is $35/mo. That's mind blowing for me.

Thanks for the input. Food costs is definitely rising to the top as our main area for improvement. I made a correction on my gas+electric spending. I put our spending for May which is not a month electric is billed in. I corrected that to show a more accurate accounting. Gas+Electric=$60/mo.

Real Estate in SoCal is definitely pricey. I'm in the LA area so even more so than other areas. I think adding a few more out of state properties might be better than buying a personal residence at the moment. The feedback I'm getting is clarifying my thinking a bit.